We usually think of taxation as just a way for the government to raise funds for their many activities. But did you know that one of the stated purposes of taxation is to try to influence people’s behaviors? There are some things that the government feels are good for society and they want to encourage people to do them. How do they encourage them? Through tax breaks.
Do you know why you get to deduct property taxes and mortgage interest when you itemize deductions? Because the government thinks it’s good for people to own homes. Do you know why the saver’s credit exists? Because the government wants to encourage even low-income earners to save for retirement. The government uses taxation to encourage certain behaviors that they feel are beneficial to society.
One way to encourage people to do something is to let them avoid paying taxes on it. They say, “We want to encourage philanthropy, so we won’t charge income taxes on money given to charities.” From a practical standpoint, how do they actually do that?
How Tax Deductions Work
Imagine if you had to report to your employer how much of your income you planned on giving to charity so that they could separate that out and not withhold taxes on that portion. (It sounds a lot like the clergy housing allowance, doesn’t it?) Even though pastors have managed to do it for the housing allowance, the IRS thinks it’s too complicated for everyone else. (Maybe you guys are just a little bit smarter and more responsible than average.) I agree with them. Especially because there are multiple behaviors that the government wants to encourage and therefore multiple things you can spend money on tax-free.
So, how can you let people spend certain money tax-free while taxing the rest of their money? The IRS does it through tax deductions. Instead of trying to separate your income between taxable and tax-free before you make your spending decisions, they do it on the back end.
When you file your tax return, you start by adding up all of your income. Then, you take out things that the government doesn’t want to tax you on. Those things you take out are called deductions.
Let’s say you make $50,000, give $8,000 to charity, and spend $7,000 on mortgage interest and property taxes. You had income taxes withheld on the full $50,000. However, on your tax return you will subtract, or deduct, the $8,000 and the $7,000 before you calculate your tax bill. After subtracting those deductions, then you have $35,000 of income for calculating the taxes you owe. That’s how the IRS lets you pay for certain things tax-free, by not including those expenses in the income used to calculate your taxes.
How An Accountable Reimbursement Plan Works
Now that you understand tax deductions, we need to go over accountable reimbursement plans, since we are looking at how they work together. Usually, any money your church gives you is taxable income. Even your housing allowance is subject to Social Security and Medicare taxes.
As a pastor, you likely spend a lot of money on church-related things. That could be anything from picking up the tab for a restaurant counseling session to renting a rototiller to landscape the church property. If your church decides to pay you a little extra to cover those miscellaneous expenses, that extra income is subject to taxes. That doesn’t seem quite right, does it?
If the church wants to be able to reimburse employees without the money being subject to taxes, they have to set up an accountable reimbursement plan. It’s simply a business expense reimbursement plan that is set up according to the IRS rules. This is how it works:
- You spend money on church-related expenses
- You report it to the church with receipts as proof
- The church reimburses you and the money is not counted as taxable income
Why You Cannot Deduct Expenses From An Accountable Reimbursement Plan
I’ve been asked several times whether or not you can deduct expenses from an accountable reimbursement plan on your tax return. The answer is NO. Why is that?
When your church reimburses you through an accountable reimbursement plan, that money is not taxed. It is tax-free. The purpose, as explained above, of tax deductions is to remove the taxes from something that the government wants you to get tax-free. If the money that you get through an accountable reimbursement plan is already tax-free, then there is no reason to deduct it. It is already tax-free. To try to deduct the expense on your personal tax return would be double-dipping and is not allowed. You can have one or the other, but not both.
In conclusion, tax deductions are good. Accountable reimbursement plans are good. Trying to deduct expenses from your accountable reimbursement plan is bad.